The Difference Between Balance Sheet and Income Statement Approaches

The balance sheet approach’s main goal is to properly value assets and liabilities. The assets are most commonly valued by the amount of money they can receive by selling that asset for or how much they spent for the asset. The determination of the accounting method depends on the nature of the underlying item and how the firm intends to use it. Earnings is a function of the change in net assets.

The income statement approach’s main goal, on the other hand, is to determine revenues, expenses, and earnings. This approach uses cash flows or the ability to generate income as its primary measurement. A common way of measuring the income streams an asset might generate would be the discounted cash flows associated with that item.

At the core, the main difference between the approaches is their concept of value. The income statement sees value as the ability to generate future earnings. Conversely, the balance sheet sees value as the amount that would be obtained if an item were sold off.

The balance sheet approach would account for property, plant, and equipment much differently than the income statement method. The BS method would value PPE at the aggregation of the costs it took attain the asset, whereas the IS method would value PPE at the discounting of the projected cash flows associated with it. Similarly, amortization and depreciation of assets might be accounted for differently with the IS approach, as the current methods may misrepresent earning ability. In addition, expenses might be recognized more aggressively in the income statement approach, as it places heavy emphasis on the matching principal.